EXCLUSIVE RESEARCH ARTICLES ON IMPORTANT ISSUES RELATING TO INCOME TAX LAW IN INDIA

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Sunday, March 17, 2013

TRADING IN CURRENCY FUTURES – WHETHER SPECULATIVE?

By Subash Agarwal, Advocate

“Whether the trading in Futures transactions
in currencies is a business transaction and not a speculative transaction and
losses incurred therein can be set-off with other business income?”

Before giving the answer,
let us first analyse the relevant provisions of the Act and the applicable
judgements of the Courts, if any and the said analysis is done hereunder-

1.
Futures transactions in
currencies are no doubt business transactions because of the profit motive,
regularity and volume involved. But it is imperative to see whether such
transactions are “speculative” in nature since the losses in speculative
transactions can be set-off only against “speculative” profits and against no
other head of income.

2.
As per section 43(5),
“Speculative transaction” means-

"a transaction in
which a contract for the purchase or sale of any commodity, including stocks
and shares, is periodically or ultimately settled otherwise than by the actual
delivery or transfer of the commodity or scrips”.

3.
Though from the plain
reading of the above definition of “speculative transaction”, the future
transactions in currencies appear to be speculative in nature, but it is
imperative to analyse the clause (d) of the proviso appended to section 43(5)
which carves out exception to the above- stated rule.

Clause (d) states that an
eligible transaction in respect of trading in derivatives referred to in clause
(ac) of section 2 of the Securities Contracts (Regulation) Act, 1956 carried
out in a recognised stock exchange shall not be deemed to be a speculative
transaction;

Further, the meaning of
the term “eligible transaction” has been explained in the “Explanation”
appended to section 43(5). Since the transactions made in the recognized stock exchanges
conforms to the criteria laid down for making the transactions eligible, it is
not necessary to discuss the same.

4.
It is worthwhile to note that section 2(ac) of the Securities Contracts
(Regulation) Act, 1956 defines “derivatives” as under-

“derivative"
includes -

(A) a security derived
from a debt instrument, share, loan, whether secured or unsecured, risk
instrument or contract for differences or any other form of security;

(B) a contract which
derives its value from the prices, or index of prices, of underlying
securities;

From the above, it is clear that “Futures” and
“Options” are part of derivative transactions. Since the value of such
contracts varies with the price of the underlying security viz., shares,
exchange rate / currency rate. In DCIT
vs. Paterson Securities (P) Ltd. 127 ITD 386 (Chennai), it was held
that a derivative is a financial instrument, the price of which has a strong
correlation with an underlying commodity, currency, economic variable or
financial instrument. The different types of derivatives are “future contracts
and options”.

5.
A confusion may arise as to whether “currency futures” is part of the term
“derivative” as defined in section 2(ac) of SCRA, particularly when the term
currency is not figuring therein. There are various reasons to come to the
conclusion that “yes, it is!”. The reasons are-

(a)
The definition of “derivative” in section 2(ac) of SCRA
is an inclusive definition, which means that any other item conforming to the
given characteristics will also qualify to be a “derivative” transaction.

(b)
SEBI was constituted by the Government to protect the
interests of the investors in securities and to promote the development of, and
regulate the securities market (see Function of the SEBI as per section 11 of
the SEBI Act, 1992).

But SEBI has also been
regulating the currency derivatives as evident from the undernoted Press
Release / Circular-

(c) Earlier,
the Central Government had notified vide Notification No. S.O. 1327 (E) dated
22.5.09, the MCX Stock Exchange Ltd., which provides India-wide electronic
platform for trading in currency futures under the regulatory control of SEBI and
RBI, as a recognized stock exchange for the purpose of section 43(5), clause (d).
(Earlier notification dated 25.01.2006 was in respect of NSE / Bombay Stock Exchange,
which dealt in ,inter alia, in derivatives relating to shares and also currencies).

Then
after United Stock Exchange of India(USE), the fourth pan India exchange, was launched for trading in financial
instruments in India and received final approval from the market regulatorSEBIto start currencyfutures
trading,
the Central Government has notified vide Notification
No. 12/2011 dated 25.2.11 the said stock Exchange also as a recognized stock
exchange for the purpose of section 43(5), clause (d)

It is worth noting that
MCX Stock Exchange Ltd. (MCX-SX) should
not be mixed-up with the Multi Commodity Exchange of India Ltd., which is
currently providing a platform for trading in commodities only. Commodity
derivatives are so far outside the ambit of sec 43(5), clause (d).

Thus the intention of the
government is also to consider currency as part of “Securities” for all
practical and legal purposes.

In view
of the above discussion, it can be concluded that “Futures” transactions in
currencies traded in the trading platform of the four recognized stock
exchanges viz., National Stock Exchange , Bombay Stock Exchange , MCX Stock
Exchange and United Stock Exchange of India are business transactions and
not speculative transactions and loss arising there from can be adjusted
against any other business income including speculative income.

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